Weekend Reading: SEC Issues Interpretive Release on Investment Adviser Standard of Conduct

In conjunction with the passage of Regulation BI and the adoption of Form CRS, on June 5, 2019, the Securities and Exchange Commission issued a wide-ranging Interpretive Release that “reaffirms” and “clarif[ies]” certain aspects of the fiduciary duty that an investment adviser1 owes to its clients under Section 206 of the Investment Advisers Act of 1940. This Client Alert focuses on the practical implications of the SEC’s views on the scope of an adviser’s fiduciary duty to clients. Investment advisers registered with the SEC should take the SEC’s views contained in the Interpretive Release into account as they manage their business.

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Overall, the SEC stated that an investment adviser’s fiduciary duty is broad, applies to the entire adviser-client relationship and is made enforceable by the anti-fraud provisions of the Advisers Act. The Interpretive Release emphasizes the SEC’s specific view that an adviser’s fiduciary duty under the Advisers Act is comprised of both the duty of loyalty and the duty of care, which, when combined and in light of the adoption of Regulation BI,2 can be characterized as requiring an investment adviser “to act in the best interests of its clients at all times.

The SEC further explained that an adviser’s fiduciary duty follows the contours of the relationship between the adviser and its client, who may shape their relationship by agreement, provided that there is full and fair disclosure and informed consent.

Finally, the SEC specifically warned the industry that an adviser may not waive its fiduciary duty.3


The SEC stated that the duty of care requires an adviser to provide investment advice in the best interests of its clients based on clients’ objectives. The SEC provided specific guidance by which an adviser can exercise care in its relationship with its clients as follows.

An Adviser Must Provide Advice That Is in the Best Interests of the Client

Notably, the SEC stated that an adviser needs to provide advice that is suitable for each client. In order to provide such advice, an adviser must have a reasonable understanding of each client’s objectives.

For retail clients, the SEC stated that an adviser should:

  • At a minimum, make a reasonable inquiry into the client’s financial situation, level of financial sophistication, investment experience and financial goals (i.e., understand the “investment profile”).
  • Update the client’s investment profile in order to maintain a reasonable understanding of the client’s objectives and adjust the advice to reflect any changed circumstances.4

For institutional clients, the SEC explained that the nature and extent of the reasonable inquiry into clients’ objectives generally is shaped by the specific investment mandates from those clients.5

For pooled vehicles, the SEC explained that the adviser would need to have a reasonable understanding of the fund’s investment guidelines and objectives.

An Adviser Must Have a Reasonable Belief That Advice Is in the Best Interests of the Client

The SEC confirmed that the duty of care includes the requirement that the adviser have a reasonable belief that advice is in the best interests of clients, and it provided specific guidance as to how an adviser can form that reasonable belief, noting the following:

  • The adviser should evaluate its advice in the context of the portfolio that it is managing for the client and the client’s objectives, taking into account the nature of the client (i.e., whether the client is a retail or an institutional client).
  • For high-risk products – such as penny stocks or other thinly traded securities – the adviser should generally apply heightened scrutiny to whether such investments fall within a retail client’s risk tolerance and objectives. A similar standard applies to complex products – such as leveraged or inverse exchange-traded funds (i.e., those designed primarily as short-term trading tools for sophisticated investors) – to the extent these products were in the best interests of a retail client initially, they would require daily monitoring.
  • The adviser should conduct a reasonable investigation into the investment so as not to base its advice on materially inaccurate or incomplete information.
  • The adviser should examine the cost (including fees and compensation) associated with investment advice, as well as the product’s or strategy’s investment objectives, characteristics (including any special or unusual features), liquidity, risks and potential benefits, volatility, likely performance in a variety of market and economic conditions, time horizon, and cost of exit.6

Finally, the SEC explained that the duty of care applies to all investment advice provided to clients, including advice about investment strategy, engaging a subadviser and account type.7

Duty to Seek Best Execution

Consistent with its prior statements, the SEC also specifically stated that an investment adviser’s duty of care includes a duty to seek best execution of a client’s transactions where the adviser has the responsibility to select broker-dealers to execute client trades. In meeting this obligation, the SEC stated that an adviser must seek to obtain the execution of transactions for each of its clients “such that the client’s total cost or proceeds in each transaction are the most favorable under the circumstances.” In seeking to further define this obligation of care, the SEC stated:

  • An adviser should seek to obtain the execution of securities transactions on behalf of a client with the goal of maximizing value for the client under the particular circumstances occurring at the time of the transaction.
  • An adviser should consider “‘the full range and quality of a broker’s services in placing brokerage including, among other things, the value of research provided as well as execution capability, commission rate, financial responsibility, and responsiveness’ to the adviser.” In other words, the SEC stated that the “determinative factor” is not the lowest possible commission cost “but whether the transaction represents the best qualitative execution.”
  • An investment adviser should “periodically and systematically” evaluate the execution of transactions it is handling for clients.

Duty to Provide Advice and Monitoring Over the Course of the Relationship

Finally, the SEC stated for the first time that an investment adviser’s duty of care encompasses the duty to provide advice and monitoring at a frequency that is in the best interests of the client, taking into account the scope of the agreed relationship.8 The SEC stated that as a general matter, an adviser’s duty to monitor extends to all personalized advice it provides to the client, including, for example, in an ongoing relationship, an evaluation of whether a client’s account or program type continues to be in the client’s best interests.


The second part of the Interpretive Release contained the SEC’s views on the duty of loyalty, which the SEC consistently has interpreted to mean that an adviser may not subordinate its clients’ interests to its own. The SEC stated that in order to meet its duty of loyalty, an adviser must make full and fair disclosure to its clients of all material facts relating to the advisory relationship, including the capacity in which the firm is acting with respect to the advice provided.9

In addition, the SEC stated that an adviser must eliminate, or at least expose through full and fair disclosure, all conflicts of interest “which might incline an investment adviser – consciously or unconsciously – to render advice which was not disinterested.” Finally, the SEC explained that whether disclosure is full and fair will depend on, among other things, the nature of the client, the scope of the services, and the material fact or conflict.10

To illustrate what it views as full and fair disclosure, the SEC provided guidance on the appropriate level of specificity that advisers should attain in their disclosure, and also discussed the considerations that investment advisers should take into account for disclosure regarding conflicts related to the allocation of investment opportunities among eligible clients.

Specificity of Disclosure

  • The SEC explained that for disclosure to be full and fair, it should be sufficiently specific so that a client is able to understand the material fact or conflict of interest and make an informed decision about whether to provide consent.
  • Moreover, the SEC explained that disclosure that an adviser “may” have a particular conflict, without more details, is not adequate if conflict actually exists.
  • The SEC elaborated that it would consider the use of “may” in disclosure to be inappropriate when the conflict exists with respect to some (but not all) types or classes of clients, advice, or transactions without additional disclosure specifying the types or classes of clients, advice, or transactions with respect to which the conflict exists.11

Trade Allocations

  • The SEC reaffirmed its prior position on how an adviser can meet its duty of loyalty with regard to trade allocations by noting that when an advisor allocates investment opportunities among eligible clients, the duty of loyalty requires the adviser to eliminate or at least expose through full and fair disclosure the conflicts associated with its allocation policies – including how the adviser will allocate investment opportunities – such that a client can provide informed consent.
  • The SEC confirmed that when allocating investment opportunities, an adviser is permitted to consider the nature and objectives of the client and the scope of the relationship and need not have pro rata allocation policies or any particular method of allocation.

In responding to commenters who objected to what they saw as subjectivity in the SEC’s proposed use of the term “informed” to describe a client’s consent to disclosed conflict, the SEC explained that full and fair disclosure does not require advisers to make an affirmative determination that a particular client understood the disclosure and that the client’s consent to the conflict of interest was informed. Rather, the SEC stated that the disclosure should be designed to put a client in a position to be able to understand and provide informed consent to the conflict of interest.12

Finally, in what can only be viewed as a warning to the industry, the SEC stated that some conflicts may be of such a nature and extent that it would be difficult to provide disclosure to clients that “adequately conveys the material facts or the nature, magnitude, and potential effect of the conflict sufficient for a client to consent to or reject it.” The SEC further warned that in some instances, disclosure may not be specific enough for a client to understand whether and how the conflict could affect the advice it receives. Specifically, for retail clients in particular, the SEC stated that where there are complex or extensive conflicts, it may be difficult to provide disclosure that is sufficiently specific but also understandable. In summary, the SEC stated that when an investment adviser cannot fully and fairly disclose a conflict of interest to a client such that the client can provide informed consent, the adviser should either eliminate the conflict or adequately mitigate (i.e., modify practices to reduce) the conflict such that full and fair disclosure and informed consent are possible.


Although the industry currently is digesting the suite of regulatory changes that the SEC adopted, given that the Interpretive Release becomes effective immediately, registered investment advisers should promptly consider examining their businesses for compliance with the Interpretive Guidance. Certain of the questions that we believe registered investment advisers need to ask include:

  • Does my code of ethics or other foundational governing document lay out that my business should be run to ensure that my business conducts itself as a fiduciary and in the best interests of our clients at all times?
  • Do my existing advisory contracts clearly describe the contours of the relationship and the services provided, and does that the contract, along with other disclosure documents, provide for full and fair disclosure and informed consent?
  • Do my advisory contracts have “hedge clauses,” and if so, are those clauses consistent with the guidance contained in the Interpretive Release?
  • Do I have sufficient processes to understand each client’s investment profile? And do I update that profile timely to reflect changed circumstances?
  • Does my firm have policies and procedures designed to provide me with a reasonable belief that the advice I provide is in my clients’ best interests? Do those policies and procedures address high-risk products for my “retail” clients? Do those policies and procedures include guidance on selecting account types and dealing with rollovers, including for prospective clients? Have I addressed each of the above questions if my firm also is registered as a broker-dealer?
  • Is how I define “best execution” in my standard advisory contract or Form ADV, Part 2, consistent with the definition contained in the Interpretive Release? Do I have best execution policies and procedures, and do those procedures require me to periodically and systematically evaluate execution on behalf of my clients?
  • Have I adopted policies and procedures designed to ensure that I monitor my clients’ accounts at an appropriate frequency and consistent with my advisory contracts?
  • Do I use the word “may” or similar words appropriately within my disclosure documents?
  • Do my trade allocation procedures consider the nature and objectives of each client and the scope of each relationship?


1 The SEC specifically noted that the Interpretive Release applies to “robo” or “automated” advisers.

2 For an overview of the impact of Regulation BI and Form CRS, please see SEC Adopts Regulation Best Interest, Form CRS, and Advisers Act Interpretations, Risk&Reward, June 6, 2019.

3 The SEC specifically stated that a contract containing (i) a statement that the adviser will not act as a fiduciary, (ii) a blanket waiver of all conflicts of interest or (iii) a waiver of any specific obligation under the Advisers Act would be inconsistent with the Advisers Act, regardless of the sophistication of the client.

Moreover, in an interesting note, the SEC withdrew the Heitman Capital Management LLC SEC Staff No-Action Letter (Feb. 12, 2007) with regard to an adviser’s ability to use a “hedge clause” within an advisory contract (i.e., where the contract seeks to relieve the adviser from liability for conduct as to which the client has a nonwaivable cause of action against the adviser provided by state or federal law). Rather, the SEC stated that whether a hedge clause violates the Advisers Act’s anti-fraud provisions depends on all the surrounding facts and circumstances, including the particular circumstances of the client (e.g., sophistication). However, the SEC warned that there are few (if any) circumstances in which a hedge clause in an agreement with a retail client would be consistent with those anti-fraud provisions. The SEC further noted that whether a hedge clause in an agreement with an institutional client would violate the Advisers Act’s anti-fraud provisions will be determined based on the particular facts and circumstances.

4 According to the SEC, the frequency with which an adviser must update a client’s investment profile should be based on facts and circumstances, including whether the adviser is aware of events that have occurred that could render inaccurate or incomplete the investment profile on which the adviser currently bases its advice.

5 Interestingly, the SEC did not define what it views to be a “retail” versus an “institutional” client. While reference can certainly be drawn to definitions contained in Regulation BI and elsewhere throughout the federal securities laws, this lack of definition might have been deliberate so as to allow each adviser to assess how to classify its client base based on its own facts and circumstances.

6 According to the SEC, when an adviser considers similar investment products or strategies, the adviser would not satisfy its fiduciary duty by simply advising the client to invest in the lowest-cost investment product or strategy without further analysis of other factors. In that regard, the SEC stated that an adviser can recommend a higher-cost investment or strategy if the adviser reasonably concludes that there are other factors about the investment or strategy that outweigh cost and make the investment or strategy one that is in the best interests of the client, in light of that client’s objectives.

7 The SEC stated that advice about account type includes advice about whether to open or invest through a certain type of account (e.g., a commission-based brokerage account or a fee-based advisory account) and advice about whether to roll over assets from one account (e.g., a retirement account) into a new or existing account that the adviser or an affiliate of the adviser manages. The SEC also specifically stated that an adviser should consider all types of accounts offered by the adviser and acknowledge to a client when the account types the adviser offers are not in the client’s best interests. The SEC also noted that investment advisers have a fiduciary duty to “prospective” clients under the anti-fraud provisions of the Advisers Act – our view about these SEC pronouncements is that the SEC was indicating that an investment adviser cannot make materially misleading statements or omissions to prospective clients to induce them to become a client, and investment advisers must be able to provide appropriate advice to the client before the relationship formally starts.

8 The SEC indicated that an adviser and client may agree to the “scope” of the frequency of such monitoring, provided that there is full and fair disclosure and informed consent. In an important note, the SEC emphasized that the frequency of monitoring, as well as any other material facts relating to the agreed frequency, will be “a material fact relating to the advisory relationship about which an adviser must make full and fair disclosure and obtain informed consent.”

9 The SEC noted the importance of disclosure for dual registrants, stating that disclosure may be accomplished through a variety of means, including, among others, written disclosure at the beginning of a relationship that clearly sets forth when a dual registrant would act in an advisory capacity and how it would provide notification of any changes in capacity.

10 The SEC helpfully noted that full and fair disclosure for an institutional client (including the specificity, level of detail and explanation of terminology) can differ from full and fair disclosure for a retail client because institutional clients generally have a greater capacity and more resources than do retail clients to analyze and understand complex conflicts and their ramifications.

11 The SEC further explained that the use of “may” in disclosure would be inappropriate if it simply precedes a list of all possible or potential conflicts regardless of likelihood and obfuscates actual conflicts to the point that a client cannot provide informed consent. On the other hand, the SEC noted that the word “may” could be appropriately used to disclose to a client a potential conflict that does not currently exist but might reasonably present itself in the future.

12 The SEC explained that a client’s informed consent can be either explicit or, depending on the facts and circumstances, implicit. Importantly, the SEC indicated that such consent need not be in writing – for example, the SEC stated that an adviser could provide appropriate disclosure through a combination of Form ADV and other disclosure and the client could implicitly consent by entering into or continuing the advisory relationship. Finally, the SEC noted that it would not be consistent with an adviser’s fiduciary duty to infer or accept client consent where the adviser was aware, or reasonably should have been aware, that the client did not understand the nature and import of the conflict.

Webcast on July 9: Practical Effects of Regulation Best Interest, Form CRS and Advisers Act Interpretations on Broker-Dealers, Investment Advisers and Investment Companies

On July 9 at 2 p.m. EDT, Larry Stadulis, Sara Crovitz and John Baker of Stradley’s Fiduciary Governance Group will host a free webcast titled “Practical Effects of Regulation Best Interest, Form CRS and Advisers Act Interpretations on Broker-Dealers, Investment Advisers and Investment Companies.” They will discuss Regulation Best Interest, Form CRS and other rules and interpretations, and their effect on registered investment advisers, registered broker-dealers and investment companies.

Register to view the webcast here.

SEC Adopts Form CRS Relationship Summary Requirement

As part of its package of new rules, forms and interpretations under both the Investment Advisers Act of 1940 and the Securities Exchange Act of 1934, the Securities and Exchange Commission has adopted a requirement that registered investment advisers and registered broker-dealers provide a brief relationship summary to retail investors on Form CRS.

This Client Alert focuses on the practical process of drafting, filing, updating and delivering Form CRS as well as legal implications for advisers and broker-dealers subject to this new requirement.

I. Purpose

The overarching purpose of the relationship summary is “to reduce retail investor confusion in the marketplace for brokerage and investment advisory services and to assist retail investors with the process of deciding whether to engage, or to continue to engage, a particular firm or financial professional and whether to establish, or to continue to maintain, an investment advisory or brokerage relationship.”1

Following the proposal of Form CRS in April 2018, the SEC’s Office of the Investor Advocate engaged the RAND Corporation to conduct investor testing on the proposed relationship summary through the administration of surveys and qualitative interviews of individual participants.2 Many commenters on the proposal expressed dissatisfaction with the scope and design of the study. For instance, one commenter stated that “the RAND Testing was not sufficiently rigorous to appropriately assess the effectiveness of Form CRS, and we strongly believe that it does not provide a reasonable basis upon which to adopt Form CRS as proposed.”3 As a result, commenters urged the SEC to delay its finalization of the proposed form until it could be determined that the disclosure in Form CRS and its utility to dispel investor confusion work as intended.

Despite these concerns, the SEC adopted the final rule without delay for further testing. In its release, the SEC noted that while it “considered this input” from commenters and used it to inform certain policy choices, “feedback we have received from or on behalf of retail investors through the RAND 2018 report, surveys and studies submitted by commenters, and input received at roundtables and on Feedback Forms, demonstrate that the proposed relationship summary would be useful for retail investors and provide information, e.g., about services, fees and costs, and standard of care, that would help investors to make more informed choices when deciding among firms and account options.”4

In the adopting release, the SEC provides for a review of the effectiveness of Form CRS to help ensure that it “fulfills its intended purpose.”5 In particular, the SEC directs the staff to review a sample of relationship summaries and provide the SEC with results of this review. There are no further details regarding the scope or timing of the review, or what the SEC will do with the staff’s report once it is provided.

Time will tell whether Form CRS will ultimately be effective to assist retail investors in understanding the scope of their engagement with an investment adviser, broker-dealer or dual registrant.

II. Presentation and Format

In response to several commenters arguing that the proposed Form CRS was too long and incomprehensible, the SEC resolved to streamline its presentation and format of Form CRS in adopting the final rule.

Instead of the four-page relationship summary that was proposed, the summary will now be limited to two pages (or four pages for dual registrants). Unlike the proposed instructions, the final instructions do not prescribe paper size, font size and margin width, but say only that they must be “reasonable.”6 The instructions also indicate that registrants should include white space and implement other design features to make the relationship summary easy to read.

Some commenters to the proposed Form CRS argued that the use of prescribed language in the instructions and the “one size fits all” approach would not appropriately address the various accounts, services and models of investment advisory and brokerage firms and therefore could be misleading to retail investors. Commenters urged the SEC to allow firms to craft their own relationship summary so that it can be tailored to the different types retail investors they service. In its adopting release, the SEC explained that, while firms will still be required to respond to a list of required topics in a prescribed order, firms will now have the flexibility to generally use their own wording to respond to the items on Form CRS.7

Several commenters to the proposed Form CRS also called for “layered” disclosure in the relationship summaries, whereby additional information could be found through cross-references, embedded URLs and QR codes. Commenters argued that “layered” disclosure would shorten and simplify the form, as well as help to alleviate the burden of having to disclose complex information that retail investors are unlikely to read. In its adopting release, the SEC states that the instructions now permit, and in some instances require, layered disclosures and otherwise encourage the use of charts, graphs, tables and other graphics to help retail investors easily digest the information.8

Additionally, in response to commenters, roundtable participants and the RAND study, which suggested that retail investors were confused with industry jargon, the final release states that in crafting their responses on Form CRS, firms will not be permitted to use legal jargon or highly technical business terms – such as “asset-based fee” and “load” – unless firms clearly explain them in plain English, even if the firm believes a reasonable retail investor would understand those terms.9

While the scope of the information required within the relationship summary has been modified in light of commenter concerns, firms are still obligated to provide accurate information and may not omit any material facts necessary to make the required disclosures, in light of the circumstances under which they were made, not misleading.10 According to the SEC, the phrase, “in light of the circumstances under which they were made,” was added to the final instructions in order to clarify that the disclosure is intended to be a summary, that firms must still adhere to the page limit, and that the instructions encourage firms to reference or link to additional information.11 Form CRS is “not intended to create a private right of action.”12

As a practical matter, firms may find it difficult to adhere to these requirements in a paper-based relationship summary. In such a format, firms must ensure that all material facts and disclosures are provided, that all technical terms are fully explained, and charts, tables or other graphics intended to help investors understand the information all fit within the confines of the two or four-page summary limit. It is unclear whether it is practical, or even possible, to disclose such information in a paper-based format within these page constraints. While the SEC permits hyperlinks and QR codes to be embedded in the text of a paper-based summary, questions remain as to the likelihood that retail investors would separately access the links provided.

III. Standards of Conduct

The RAND 2018 Report and other surveys found that retail investors struggled to understand the standard of care for broker-dealers and investment advisers after reading the proposed Form CRS, and RAND reported that survey participants especially had difficulty reconciling the information provided in the “Obligations to You” section and the “Conflicts of Interest” section. In addition, commenters noted that retail investors did not understand the differences between a “best interest” and “fiduciary” standard, with at least one commenter noting that the confusion is likely attributable to a lack of clarity regarding the standards themselves. Yet as shown in the final release for Regulation Best Interest, broker-dealers and investment advisers will continue to be subject to different standards of conduct despite the SEC’s efforts to harmonize the obligations.

In the final release, firms will remain subject to the requirement to describe their legal standard of conduct using prescribed wording, but the standard of conduct disclosure is provided in the conflicts of interest section.13 The modified standard of conduct disclosure now eliminates legal jargon, such as “fiduciary,” and instead uses the term “best interest” across the board, to describe how broker-dealers, investment advisers, and dual registrants must act regarding their retail customers or clients when providing recommendations as a broker-dealer or when acting as an investment adviser.

This decision is notable, considering that the final form of Regulation Best Interest still does not place a “fiduciary standard” on broker-dealers, and thus one could argue that the standards of conduct are inherently different. The harmonizing of the standard of care under Form CRS, however, appears to imply that the broker-dealer standard is as high as a fiduciary standard, even though it is not defined as such. In this regard, the SEC noted that, “we believe that requiring firms – whether broker-dealers, investment advisers, or dual registrants – to use the term ‘best interest’ to describe their applicable standard of conduct will clarify for retail investors their firm’s legal obligation in this respect, regardless of whether that obligation arises from Regulation Best Interest or an investment adviser’s fiduciary duty under the Investment Advisers Act.”14

The SEC states in the adopting release that the prescribed language describing the standard of conduct broker-dealers and investment advisers owe to their customers and clients is not intended to create a private right of action.15 The SEC did not address the possibility that such disclosures might support claims under existing private rights of action, such as that under rule 10b-5 under the Exchange Act.

IV. Contents of the Relationship Summary

The final instructions for the relationship summary require a question-and-answer format, with standardized questions serving as the headings in a prescribed order to promote consistency and comparability. The headings will be structured and machine-readable. Under the standardized headings, firms will generally use their own wording to address the required topics, although some specific disclosures are prescribed. Firms will also be required to link to additional information, which for investment advisers will be to their Form ADV Part 2A brochures or equivalent information and for broker-dealers will be to their Regulation Best Interest disclosures.

In particular, the required headings address: (i) identifying information about the firm and a link to the SEC’s website; (ii) the types of client and customer relationships and services each firm offers; (iii) the fees, costs, conflicts of interest, and required standard of conduct associated with those relationships and services; (iv) whether the firm and its financial professionals currently have reportable legal or disciplinary history; and (v) how to obtain additional information about the firm.

Some of the “Key Questions to Ask” from the proposal have been integrated into the relationship summary sections as required “conversation starters.” The SEC intends that retail investors can use these questions to engage in dialogue with their financial professionals about their individual circumstances.

V. Delivery, Filing, Updating and Recordkeeping Requirements

Under the final rule, investment advisers and broker-dealers will be obligated to deliver a relationship summary to retail investors at a certain time before or during the engagement, file copies of their relationship summaries with the SEC, update the disclosures when the information becomes materially inaccurate, and communicate any changes to retail investors who are existing clients or customers.

The relationship summary requirement applies to investment advisers and broker-dealers with retail investors. If a firm does not have any retail investors, it is not required to prepare or file a relationship summary. In particular, it appears that investment advisers to institutional separate accounts, private funds and registered funds will not be required to deliver Form CRS. In addition, the adopting release states that the SEC would not consider a broker-dealer that is serving solely as a principal underwriter to a mutual fund or variable annuity or variable life insurance contract issuer to be offering services to a retail investor for this purpose, when acting in such capacity.16

a. Retail Investor

The SEC’s final rule defines a retail investor as a natural person, or the legal representative of a natural person, who seeks to receive or receives services primarily for personal, family or household purposes. The SEC interprets a “legal representative” of a natural person to cover only non-professional legal representatives (e.g., a non-professional trustee that represents the assets of a natural person and similar representatives such as executors, conservators, and persons holding a power of attorney for a natural person).17 The definition excludes natural persons seeking services for commercial or business purposes (though a relationship summary is required to be delivered to those persons who might be seeking services for a mix of personal and commercial or other non-personal purposes).18 The definition does not distinguish based on a net worth or other asset threshold.19 In addition, in response to commenter concerns regarding whether the definition includes plan participants, the SEC clarified that the definition will include a natural person seeking to select and retain a firm to provide brokerage or advisory services for his or her own retirement account, including but not limited to IRAs and individual accounts in workplace retirement plans, such as 401(k) plans and other tax-favored retirement plans.20

In its adopting release, the SEC stated that while the final instructions adopt a definition of “retail investor” that is consistent with the definition of “retail customer,” it differs to reflect differences between the relationship summary delivery requirements and the obligations of broker-dealers under Regulation Best Interest, including “that the relationship summary is required whether or not there is a recommendation and covers any prospective and existing clients and customers (i.e., a person who ‘seeks to receive or receives services’) of both investment advisers and broker-dealers.”21

b. Delivery

For investment advisers, the SEC requires delivery of a relationship summary before or at the time the firm enters into an investment advisory contract and is intended to generally track the initial delivery requirement for Form ADV Part 2A. However, in a change from the proposal, broker-dealers must deliver the relationship summary to each new or prospective customer who is a retail investor before or at the earliest of one of three triggers: (i) a recommendation of an account type, a securities transaction, or an investment strategy involving securities; (ii) placing an order for the retail investor; or (iii) the opening of a brokerage account for the retail investor. Dual registrants, and affiliated broker-dealers and investment advisers that jointly offer their services, must deliver at the earlier of the initial delivery triggers for an investment adviser or a broker-dealer.

In response to commenters’ concerns, the SEC also adopted rules for delivery when changes are made to an existing account that would “materially change the nature and scope” of the firm’s relationship with the retail investor. For example, firms will be required to deliver the relationship summary to existing retail investors: (i) before or at the time firms open a new account that is different from the retail investor’s existing account; (ii) when they recommend that the retail investor roll over assets from a retirement account; or (iii) when they recommend or provide a new service or investment outside of a formal account (e.g., variable annuities or a first-time purchase of a direct-sold mutual fund through a “check and application” process).

To facilitate retail investors receiving the relationship summary as early as possible, a firm may deliver the initial relationship summary to a new or prospective client or customer in a manner that is consistent with how the retail investor requested information about the firm or financial professional (e.g., by email if information requested by email).22 The SEC is not requiring that firms make the initial relationship summary available in paper format and believes that retail investors that prefer paper communications will have the opportunity to establish relationships with firms that accommodate paper delivery.23 With respect to existing clients or customers, firms must comply with the SEC’s electronic delivery guidance, which provides that a person who has a right to receive a document under the federal securities laws and chooses to receive it electronically, should be provided with the information in paper form whenever specifically requesting paper.24

c. Filing

Relationship summaries will be filed by broker-dealers on Form CRS through Web CRD and by investment advisers as Form ADV Part 3 (Form CRS) through IARD, using a text-searchable format. Dual registrants will file using both IARD and Web CRD. The use of Web CRD instead of EDGAR, as proposed, is to allow broker-dealers to use a platform which, according to commenters, is more accessible and familiar to them. The summaries will be accessible via the SEC’s public website, Investor.gov, in addition to each firm’s website.25

d. Updating

Broker-dealers and investment advisers must update the relationship summary and file it within 30 days whenever any information in it becomes materially inaccurate, and any changes must be communicated to existing clients or customers within 60 days (instead of 30 days as proposed). In a change from the proposal, the SEC also added a requirement that firms delivering updated relationship summaries to existing clients or customers must highlight the most recent changes by, for example, marking the revised text or including a summary of material changes.26 This additional disclosure must be filed as an exhibit to the unmarked amended relationship summary (but would not be counted toward the two-page or four-page limit, as applicable).

e. Recordkeeping

The SEC is adopting amendments to the recordkeeping and record retention requirements under Advisers Act rule 204-2 and Exchange Act rules 17a-3 and 17a-4. Pursuant to paragraph (a)(14)(i) of Advisers Act rule 204-2 as amended, investment advisers will be required to make and preserve a record of the dates that each relationship summary was given to any client or prospective client who subsequently becomes a client. New paragraph (a)(24) of Exchange Act rule 17a-3, as adopted, will require broker-dealers to create a record of the date on which each relationship summary was provided to each retail investor, including any relationship summary provided before such retail investor opens an account. In addition, paragraph (a)(14)(i) of Advisers Act rule 204-2, as amended, will require investment advisers to retain copies of each relationship summary and each amendment or revision thereto while paragraph (e)(10) of Exchange Act rule 17a-4, as amended, will require broker-dealers to maintain and preserve a copy of each version of the relationship summary as well as the records required to be made pursuant to new paragraph (a)(24) of Exchange Act rule 17a-3. The amended rules also set forth the manner in which and the period of time for which these records must be retained.

The recordkeeping requirements were adopted as proposed, despite concerns from commenters that the requirements as written would be burdensome, especially with regard to maintaining records of prospective clients and customers who do not become clients or customers. The SEC indicated that the collection of information will be used in its examination and oversight program.27

VI. Compliance Date

In the final rule, the SEC extended the time to comply with the relationship summary requirements. In the adopting release, the SEC noted that firms that are registered, or investment advisers who have an application for registration pending, with the Commission prior to June 30, 2020, will have a period of time beginning on May 1, 2020 until June 30, 2020 to file their initial relationship summaries with the SEC. On and after June 30, 2020, newly registered broker-dealers will be required to file their relationship summary with the SEC by the date on which their registration with the SEC becomes effective, and the SEC will not accept any initial application for registration as an investment adviser that does not include a relationship summary that satisfies the requirements of Form ADV, Part 3: Form CRS.28 It is not clear what the review process will be at the SEC for relationship summaries and whether that process could slow down effectiveness of newly registering investment advisers, or whether existing broker-dealers and investment advisers should anticipate comments on their relationship summaries.

Firms will be required to deliver their relationship summary to new and prospective clients and customers who are retail investors as of the date by which they are first required to electronically file their relationship summary with the SEC. In addition, firms will be required, as part of the transition, to deliver their relationship summaries to all existing clients and customers who are retail investors on an initial one-time basis within 30 days after the date the firm is first required to file its relationship summary with the SEC.


1  Form CRS Relationship Summary; Amendments to Form ADVRelease Nos. 34-86032, IA-5247, at 5 (June 5, 2019) (footnotes omitted); see also Exhibit B: Instructions to Form CRS.

2  Form CRS Relationship Summarysupra Note 1, at 9.

3  Investment Adviser Association, Investor Testing of Form CRS Relationship Summary, at 2 (Dec. 4, 2018). See also Consumer Federation of America, File No. S7-08-18, Form CRS Relationship Summary, at 1 (Dec. 7, 2018) (the “inescapable conclusion” from the study is that the disclosures in the proposed Form CRS do not, as currently conceived, “actually support informed investor decision-making” and that many investors still fail to understand “key information that would help them determine whether a brokerage or advisory account would best suit their needs.”).

4  Form CRS Relationship Summary, supra Note 1, at 11 – 12.

5  Id. at 28 – 29.

6  The adopting release indicates that 8½” x 11” paper size, at least an 11 point font size, and a minimum of 0.75” margins on all sides could be considered reasonable, but other parameters could also be reasonable. Id. at 48.

7  Id. at 21, 37.

8  Id. at 21 – 22.

9  Id. at 33.

10  Instructions to Form CRS, supra Note 1, General Instruction 2.B.

11  Form CRS Relationship Summary, supra Note 1, at 42 (emphasis in original).

12  Id. at 43.

13  Id. at 143 – 44.

14  Id. at 153 – 54.

15  Id. at 145.

16  Id. at 224 – 25.

17 Id. at 195. In other words, delivery of the relationship summary to regulated financial services professionals acting as representatives of a natural person is not required.

18  Id. at 193.

19  Id. at 193 – 94.

20  Id. at 197. In addition, the SEC noted that participants in 401(k) plans and other workplace retirement plans will not be retail investors for purposes of the Form CRS delivery obligation when making certain ordinary plan elections that do not involve selecting or retaining a firm to provide brokerage or advisory services. Id. at 198.

21  Id. at 191.

22  Id. at 207 – 08.

23  Id. at 213 – 14.

24  Id. at 208, 211 – 212; see Use of Electronic Media by Broker- Dealers, Transfer Agents, and Investment Advisers for Delivery of Information; Additional Examples Under the Securities Act of 1933, Securities Exchange Act of 1934, and Investment Company Act of 1940, Release Nos. 33–7288, 34–37182, IC–21945, IA–1562 (May 9, 1996), 61 Fed. Reg. 24644, 24646 (May 15, 1996).

25  Form CRS Relationship Summarysupra Note 1, at 201.

26  Id. at 189.

27  Id. at 479.

28  Id. at 239.

Massachusetts Follows in New Jersey’s Footsteps by Proposing Similar Fiduciary Duty Rule Applicable to Broker-Dealers and Investment Advisers

Massachusetts’ fiduciary duty proposal is the first such action of any state in the wake of the Securities and Exchange Commission’s adoption of Regulation Best Interest, and its close similarity to New Jersey’s proposal may suggest a model is emerging.

William F. Galvin,
Secretary of the Commonwealth of Massachusetts

A mere nine days after the Securities and Exchange Commission (SEC) voted to approve its standards of conduct rulemaking, including Regulation Best Interest, the Massachusetts Securities Division (Division) circulated for preliminary comment a regulation that would impose a fiduciary standard of care on broker-dealers and investment advisers. The June 14 announcement by the Division marked the first state to respond to the SEC’s adoption of its own standard of conduct rulemaking. The Massachusetts proposal (Proposal) is also very similar to the New Jersey uniform fiduciary duty proposal. As further described below, the comment period for the Proposal closes on July 26.

Before delving into the Proposal, we note some big picture considerations:

  1. The fact that the Proposal is so similar to New Jersey’s may suggest an emerging model of regulation with respect to uniform standards of conduct is afoot. This would be a double-edged sword in that it would result in less variance among the state approaches to standards of conduct, while also magnifying the scope and interpretive issues of, and preemption issues related to, the New Jersey proposal.
  2. As the Proposal goes beyond Regulation Best Interest, federal preemption – including by reason of the National Securities Markets Improvements Act – will come into sharper focus. The Proposal, as with New Jersey’s, seeks to address preemption concerns for broker-dealers by providing that it does not establish “any requirements for capital, custody, margin, financial responsibility, making and keeping of records, bonding, or financial or operation reporting for any broker-dealer or agent that differ from, or are in addition to, the requirements established under 15 U.S.C. § 78o(i).”
  3. The Proposal is the first formal response from a specific state in the wake of the SEC standards of conduct package. The Division made numerous criticisms of the SEC rulemaking, including:
    1. Regulation Best Interest did not define “best interest”;
    2. Regulation Best Interest “sets ambiguous requirements for how longstanding conflicts in the securities industry must be addressed under the new rule”;
    3. The SEC failed “to indicate whether some of the most problematic practices in the securities industry would be prohibited under the new rule.” For example, while the Division acknowledged that Regulation Best Interest would disallow product-specific sales contests, “it did not indicate that broader-based sales contests or quotas would be contrary to its requirements”; and
    4. At least “in many instances,” the mitigation of conflicts of interest required under Regulation Best Interest can be achieved through disclosure on Form CRS (see below on how the Proposal addresses disclosure as a method to address conflicts of interest).
  4. Absent the SEC adopting a uniform fiduciary duty standard, the Division appears to have been unlikely to be swayed by an SEC rulemaking, as the Division all but admitted in its press release. Previous enforcement actions brought by the Division, and statements by William Galvin, its head, were also prior warnings that the Division would proceed with the Proposal despite the SEC rulemaking.

Below is a summary of the core components of the Proposal.

  • Recommendations: The Proposal covers advice or recommendations by a broker-dealer or investment adviser, or their respective agents or representatives, with respect to (1) an investment strategy; (2) the opening of, or transfer of assets to, any type of account (including recommendations to open IRA roll-over accounts); or (3) the purchase, sale or exchange of any security.
    • For purposes of the Proposal, an “adviser” means “any person, including persons registered or excluded from registration under M.G.L. c. 110A, who receives any consideration from another person primarily for advising the other person as to the value of securities or their purchase and sale, whether through the issuance of analyses or reports or otherwise.” The Proposal adds that, “[i]t is a rebuttable presumption that such term includes all investment advisers and investment adviser representatives, as well as other persons who charge fees based on assets under management or portfolio performance for rendering investment advice.”
  • Retail Investors: The Proposal applies to advice and recommendations that are provided to a “customer” or “client.” The Proposal defines these terms by what they are not, namely, by excluding (1) a bank, savings and loan association, insurance company, or registered investment company; (2) a broker-dealer registered with a state securities commission (or agency or office performing like function); (3) an investment adviser registered either with the SEC under Section 203 of the Investment Advisers Act of 1940 or with a state securities commission (or agency or office performing like function); and (4) certain “institutional buyers,” within the meaning of 950 CMR 12.205(1)(a)6 (e.g., an organization described in Section 501(c)(3) of the Internal Revenue Code with a securities portfolio of more than $25 million, an investing entity whose investors are only accredited investors, as defined in Rule 501(a) of the Securities Act of 1933, and each of whom has invested a minimum of $50,000, etc.). Regulation Best Interest, in contrast, applies to recommendations made to natural persons acting for their own account, regardless of sophistication.
  • Fiduciary Duties: The advice or recommendation by a broker-dealer, agent, or investment adviser must satisfy the duties of care and loyalty.
    • Duty of Care: A broker-dealer, agent or adviser must use “the care, skill, prudence, and diligence that a prudent person acting in a like capacity and familiar with such matters would use taking into consideration all of the facts and circumstances.” The Proposal indicates that, specifically, this duty requires a broker-dealer, agent or adviser to “make reasonable inquiry, including risks, costs, and conflicts of interest related to the recommendation or investment advice, the customer’s or client’s investment objectives, financial situation, and needs, and any other relevant information.”
    • Duty of Loyalty: The duty of loyalty requires a broker-dealer, agent or adviser “to avoid conflicts of interest,” and that each recommendation or advice is made without regard to the financial or any other interest of the broker-dealer, agent, adviser, any affiliated or related entity or its officers, directors, agents, employees or contractors, or any other third party.
    • Disclosure of Conflicts of Interest: There is no presumption “that disclosing a conflict of interest alone” satisfies the duty of loyalty. This will attract a lot of attention because, generally speaking, disclosure under the Investment Advisers Act of 1940, as amended (including the new Interpretive Release, and under Regulation Best Interest, may be sufficient to cure many conflicts of interest.
    • Problematic Practices: There is a presumption of a breach of the duty of loyalty “for offering, or receiving, direct or indirect compensation to or from a broker-dealer, agent, or adviser for recommending an investment strategy, the opening of, or transferring of assets to a specific type of account, or the purchase, sale, or exchange of any security that is not the best of the reasonably available options for the customer or client.” The sale of proprietary products, principal transactions, and broad-based sales contests/quotas, are likely implicated here.
    • Transaction-Based Remuneration: The Proposal states that there would not be presumed a breach of the duty of loyalty for the broker-dealer, agent or adviser to receive transaction-based remuneration if the amount is reasonable and it is the best of the reasonably available remuneration options for the customer or client. The Proposal does not explain how a broker-dealer could demonstrate that a commission, for instance, is the best of the reasonably available fee options, a shortcoming we also identified with the New Jersey proposal.
  • Duration of Fiduciary Duties: If a broker-dealer, agent or adviser makes a standalone recommendation, the fiduciary duties “extend through the execution of the recommendation and shall not be deemed an ongoing obligation.” Importantly, if a broker-dealer, agent or adviser (1) makes ongoing recommendations, (2) provides investment advice in any capacity to the customer/client, or (3) receives ongoing compensation in connection with the recommendation or advice, then the fiduciary duty is deemed to be ongoing. This raises the possibility that broker-dealers will have ongoing fiduciary duty for recommendations made to a retail investor’s brokerage account when either that broker-dealer (1) is dually registered and also provides investment advisory services to the same investor or (2) separately provides investment advice to the investor.
  • Exclusion of ERISA Plans: The Proposal specifically excludes from coverage any recommendation or advice given by a fiduciary to an employee benefit plan, or its participants or beneficiaries, under the Employee Retirement Income Security Act of 1974, as amended (ERISA). This exclusion does not appear to extend to communications to ERISA plan participants that are not fiduciary in nature under ERISA, such as investment education.

Written comments on the Proposal must be received no later than Friday, July 26, 2019 at 5:00 p.m.

Submission via Mail
Please mail any comments on the proposed amendments to:

Office of the Secretary of the Commonwealth
Attn: Proposed Regulations – Fiduciary Conduct Standard
Massachusetts Securities Division
One Ashburton Place, Room 1701
Boston, MA 02108

Submission via Facsimile
Faxed comments may be sent to 617-248-0177. Comments sent via facsimile should include a cover sheet to the attention of “Proposed Regulations.”

Submission via Email
Email comments or submissions of scanned comment letters attached to an email may be submitted to securitiesregs-comments@sec.state.ma.us.